Regulation Can't Fix Culture: When a whole industry is at a crossroads

Episode #33 Regulation Can't Fix Culture: When a whole industry is at a crossroads

The Hayne Royal Commission was named after Commissioner Kenneth Hayne. Hayne was one of the nation’s top jurists, having served as a judge on the High Court of Australia, the highest court in the land. He presided over a massive inquiry into the Australian financial sector with broad and sweeping powers of discovery and compulsion and witnesses.

The commission brought down a number of top executives and non-executive directors. Cost to the taxpayers in Australia, $75 million. But the estimated cost for every single institution that had to respond was about $50 million each. So we’re talking about a shindig that cost at least a billion dollars. And the cost of remediation is going to be multiples of this.

A whole industry of risk and compliance has sprung up. And a new conservatism has been driven into the retail and institutional lending. However, it was completely warranted and the findings have exceeded the expectations of even the most left wing trade unionists for their salaciousness and the brazen nature of some of the behaviours.

The commission uncovered a culture of greed in some pockets of the financial sector. So for example, some cases of money laundering for drug syndicates, some of turning a blind eye to terrorism financing, some ignoring statutory reporting responsibilities and others impropriety in foreign exchange trading. So while we’re all going ‘Ooh’ and ‘Ahh’ at our terrible Eddie’s, don’t forget that we’re only seeing the headlines here, and sometimes below that is the real story. So some of those instances were nothing more than an era in software design and release, where reports stopped being issued that would uncovered some of these problems for the managers involved.

Let’s try to remain a little bit balanced. I know what it’s like to work in an industry that’s plagued by populist anti-business sentiment. No, I’m not saying it doesn’t need to be some sort of reset here for the financial institutions and we’ll get onto this, but we all tend to have pretty short memories of times like these.

Now remember, if it weren’t for the strength of the banks, Australia would not have been the only country in the developed world that came through the global financial crisis of 2008 relatively unscathed. There are hundreds of thousands of good people who work for these institutions who are just like you and me trying to do the right thing and provide a service to the community. And who takes most of the risk when you buy the family home? The lenders do. So let’s stay a little balanced people

it’s not just australia, it’s worldwide

Let’s look at this on a broader scale here, because this is not confined to Australia and it’s certainly not confined to the banking sector. Just last week The Economist published an article on what it calls the slipping standards in corporate America. Now American firms count for 57 of the world’s hundred most valuable companies by market cap and there are a number of well documented transgressions of recent times. So for example, Boeing is accused to commissioning their 737 MAX 8s with problematic software that allegedly caused two fatal crashes within months of each other.

Goldman Sachs is facing criminal charges in Malaysia for financing of fraudulent fund with $6.5 billion dollars of debt funding. Ms. Santo allegedly failed to warn the customer that it’s weed killer could cause cancer. Wells Fargo created 3.5 million unauthorised bank accounts and a lawsuit has been brought against Purdue Pharma, the maker of OxyContin for allegedly practising sales techniques that fueled the current opioid epidemic.

In terms of holding people to account for this, we’re just a little slow. In the vast majority of cases, the executive remuneration pulls in these companies have not suffered one little bit. In the case of the ten companies engulfed in a scandal at the moment that were analysed, the executive rem pool increased over the last four years to almost $600 million. Now, The Economist says that three forces are supposed to keep these organisations in check and they are regulation, litigation and competition.

And regulation is pretty tough and many failings are allegedly due to underfunding and lack of the necessary clout to hold the organisations to account. So for example, the FAA is accused of being too close to Boeing. Then of course the FDA approved the drugs that were sold by Purdue Pharma. So what’s the thesis? The weakening of competition has made market power more concentrated and the impacts of any transgression are more readily absorbed by these organisations. It’s harder for the customer to shift because choices are fewer.

Let’s get back to the Australian financial institutions for a minute. Hayne and made for primary observations.

1. That all the transgressions were driven by pursuit of profit and personal gain.

2. They acted in that way because they could.

So there was an information asymmetry and customers didn’t really understand what they were choosing. But this is clearly not the only industry where the customer doesn’t understand the product. Has anyone ever bought a cell phone plan and seeing how difficult it is to understand and compare different players from different providers? Who actually understands their electricity bill when it comes at the end of every quarter? The only thing governing the institutions was their sense of what was right.

3. Intermediaries are not motivated in the best interest of the customer.

4. Institutions were not properly held to account when they did transgress. So in other words, the regulation in the industry was weak and ineffective

Primary responsibility or blame in the eyes of the punter for this behaviour lays squarely with the boards and senior management of the institutions, all driven by pursuit of profit and personal gain.

Who are the winners and losers?

While a number of CEOs fell on these sorts, one notable casualty, a chairman who is or at least was one of the most respected names in Australian business, resigned after an appearance before the commission that can only be described as arrogant and wildly out of touch with community expectations and standards. Enter stage left Nicholas Moore, chief executive of Macquarie Bank.

Now he was held in the press as being the exemplary performer throughout the commission, and there was even a headline in the Australian Financial Review that read, “Macquarie CEO, Nicholas Moore shows why he is paid $19 million.” This will be good I thought.

His testimony before the commission included how he managed to shift the culture at Macquarie Bank. It’s really as simple as this. When ESIC, the corporate regulator brought lack of compliance reporting to Moore’s attention, he actually responded. He fired the responsible managers and some stockbrokers. He met a compliance report to head office. He compensated customers and he cuts someone seniors’ pay.

Really?

That’s the $19 million man.

Okay, great work, Nicholas Moore. But how on earth does this rank as exceptional?

Any senior manager worth his salt would take decisive action upon uncovering illegal, fraudulent, or unethical conduct, right?

Well, here’s a pop quiz. Ask yourself this question.

Have you ever been in the situation when somebody, the internal or external to your organisation has come to you with a complaint. Bullying, fraud, sexual harassment, behaviour at odds with the organization’s values? If so, what did you do? Is your first instinct to dismiss it and cover it up or do you play a straight bet and seek the truth by trying to get to the bottom of the incident, irrespective of the consequences for you as a leader and for the people involved?

Culture as much, as anything else, is a function of what leaders allow to take place. It doesn’t matter what impassion speeches a leader gives to the troops. What matters is how the cultural standards are set. And it’s moments like these that you tell your people what you expect and what you allow.

During my career, I’ve seen some very senior people cover up some very serious misconduct. And for the life of me I don’t understand why. Do they have fear of repercussions? Is it a problem with the perceptions of their leadership they think might get out?

I’ve seen people engage in extreme misconduct being quietly shown the door with a huge bag of cash to be quiet and no censure. So inappropriate and weak are the messages sent by the leaders who do this that I’ve even seen cases where the offending individuals take legal action against the company for wrongful dismissal.

That is leadership at its weakest and unfortunately all too examples spring to mind in my career, and remember I’ve never worked as an executive in the banking sector.

5 rules of thumb for creating a culture of ethical behaviour

1. As a leader, you alone are responsible for setting the cultural standards

I want to take a few quotes from the Hayne report at this point. In the summary piece, the observations on culture, governance and remuneration, which interestingly were all grouped together, seemed almost facile. I thought, well what can you expect from an eminent jurist who probably has never had to deal with this stuff in the heat of battle?

But when I actually got into the full chapter on culture, governance and remuneration, it was a revelation. Hayne seems to really understand this stuff and the balance required to successfully transform these businesses.

I want to take two quotes in particular from the final report because of their relevance to culture and leadership. So here’s the first one.

“It is rightly said that the tone of the entity is and must be set from the top, but that turned must also be echoed from the bottom and reinforced at every level of the entity’s management and supervision. It must always sound from above. And a culture that fosters poor leadership, poor decision making or poor behaviour will undermine the governance framework of the entity.”

This is absolutely spot on the money.

And the key point is that you have to have it through every single layer of leadership. You can’t just think that what you say in the corner office is going to make a difference to what happens on the ground. And the second quote,

“Culture cannot be prescribed or legislated. Proper governance, a healthy culture and accountability are desired outcomes. But they cannot be imposed by rules that say you must or you may not. Culture is about behaviours. Behaviours in general are not amenable to legislation or regulation. Sustainable cultures need to arise from and be embedded in the organization’s DNA.”

The natural reaction for the organisations involved, particularly the big banks, is to bulk up the risk and compliance activities. They’ve become more conservative in a range of ways and they’ve spot a massive growth in the risk and compliance industry, both inside their organisations and for the high end consulting firms. Will this ultimately prevent what has happened to date? Will it genuinely transform the culture? I seriously question whether many of the institutions and there are exceptions of course, have taken the steps to turn the culture around.

2. The best disinfectant is sunlight

As a leader, you need to seek out and squash any behaviours that accounted to your organization’s values and the tone that you’re trying to set. Rather than glossing over, covering up or making excuses, if ever you are brought an issue of poor, culture and behaviour, take the strongest possible action allowed. Get these things into the open and cast a big spotlight on anything that doesn’t pass the smell test. Make It really clear to your people that you simply won’t tolerate any shenanigans. This really has an impact on culture.

3. Don’t be afraid to shoot a hostage (I know this sounds harsh)

Now, to tell you the truth, I love seeing people’s faces when I drop this out in my keynote addresses. But if you find someone who constantly behaves in a way that at odds with the culture you’re trying to create, you need to get them out of the organisation.

It doesn’t matter whether it’s your top sales person, you’re most knowledgeable engineer, your highest billing lawyer, it doesn’t matter, and you got to let them go loudly, not quietly. You’ve got to actually tell the organisation what’s acceptable and what’s not. You’ve got to set an example. And even to the point where you take some legal and industrial relations risk if necessary to terminate someone.

But whatever you do, don’t let the rest of the organisation think that their behaviour is okay if it’s not.

4. Curb your self-interest

When it comes to the choice between the money and the culture, you have to go with the culture every single time. But this is easier said than done. I see leaders all the time rationalising as to why they don’t need to take decisive or difficult action. They can always a way to justify it intellectually if it benefits them financially. If you don’t get on top of this, your long-term interest will be severely damaged by having a team of people with poor behaviours, attitudes and conduct, and eventually they all come home to roost.

I’ve seen a lot of executives who are financially well off but intensely unhappy. And my hypothesis is that to get to where they are, sometimes they do things that sacrifice too much of their integrity on the way through and most of us have a pretty accurate internal barometer for this.

5. Model it, communicate it and get your own house in order first

The world is coloured in shades of grey, not black and white. But we all know right from wrong, and heading down that slippery slope of unethical behaviour starts with micro decisions that we don’t think other people will notice. Just don’t succumb to this.

In past roles I’ve had to explicitly address whole sections of a workforce to talk about commonly accepted cultural practises which are simply at odds with my values. I remember one side in particular a number of years ago where I had to stand up in front of a few hundred marginally hostile people and I opened by saying, “I can’t believe I’m about to say this, but appears from a range of conversations with your leaders that I actually need to, just to avoid any confusion. Here’s some clear guidelines for you to work with. Now bear in mind that this list is indicative and not exhaustive,” I said.

“Changing or doctoring your time sheets to claim over time is not acceptable. It’s theft. Engineering your roster to take scheduled absences to maximise your earnings is theft. Taking sick leave when there’s no legitimate reason is theft. Taking materials home from the warehouse to use as personal suppliers is theft. If I hear of anyone doing this, I give you my deep, personal commitment that I will sack you without hesitation or regard for the circumstances.“

Now that was some pretty tough talking I had to do, but it was completely warranted because this culture had grown in a way that said, this stuff is just what we do. And interestingly, the site general manager had a much less strident view on this than I did and spent a lot of time covering up these incidents as being cause of conduct issues. In other words, he held the philosophy that they’ve been doing this for years, so we have to expect the odd transgression and we need to help them to change, bullshit.

I don’t want to sound cynical, but in the case of this particular part of the business, they would do whatever they knew they could get away with. Why? Because it was part of the culture.

BEFORE YOU TAKE A TOUGH STANCE…

If you as a leader decide that you are going to take a tough stance, you’d better make sure that you personally are squeaky clean in that regard.

When I gave that speech, I knew that I was painting a target on my back. I had a few hundred people that would have loved to see me do something unethical or self-gratifying. But more than that, if you don’t hold the same high standards for yourself, then your people will see you as a hypocrite very, very quickly. Is that the leadership brand you want?

In closing, I seriously doubted the majority of institutions shamed by the Hayne Royal Commission will take the necessary steps to fix their culture. They’ll do some stuff right. They’ll do the obvious things and they’ll burn vast amounts of shareholder wealth while doing so. They’ll definitely make changes to remuneration commission structures. They will absolutely increase governance risk and compliance oversight. They’ve already, for the most part, issued more conservative guidelines for lending and dealing with customers.

But will they do the hard work of leadership? That’s the $64,000 question.

Are they prepared to make an example of those who they know have behaved badly or will they accept that as the fault of the system, not the individual? Will they take the smartest people with the worst behaviour and excise them from the organisation? Will they demand a new focus on ethical behaviour and police it diligently? Will they invest in the processes and capability needed to screen these behaviours out at the point of hiring and of promotion? And will they genuinely penalise people financially for bad behaviours and misconduct? And what will be the next industry to fall?

I could take financial services and substitute a number of other industry names that will never be subject to the intrusive scrutiny of a Royal Commission.

My hope and the point of this podcast is that we all take heed from the lessons of Hayne without having to live through the pain ourselves